Pakistan steps up Islamic finance in infrastructure deals

April 27 (Reuters) - Pakistan is stepping up its use of sharia-compliant financing to fund infrastructure deals, which could help to promote the use of longer-term transactions in Islamic finance.

Islamic deals are backed by specific assets, which makes them convenient for infrastructure projects. But traditionally, Islamic bonds and loans have shorter tenors - often around five years - than their conventional equivalents.

This is partly because Islamic markets are generally not as deep and liquid, and products are not as standardised. Also, Islamic banks mostly hold short-term deposits on their books.

This month, however, Pakistani banks arranged 100 billion rupees ($955 million) worth of 10-year Islamic bonds (sukuk) for a hydropower plant, the largest infrastructure deal to use Islamic financing in the country.

Opportunities for similar deals are growing with $45 billion worth of domestic infrastructure projects planned by Pakistan’s government under an initiative dubbed the China-Pakistan Economic Corridor (CPEC), agreed between the states in 2014.

Islamic banks have become increasingly willing to manage any mismatch between their short-term deposit bases and such long-term projects, said Abdullah Ghaffar, head of investment banking at Al Baraka Bank Pakistan.

“Excess liquidity with Islamic banks is pushing them towards each and every opportunity emanating from the CPEC,” Ghaffar said.

The government is providing encouragement; in November, Finance Minister Ishaq Dar said predominantly Muslim Pakistan wanted to make sharia-compliant financing its first choice for infrastructure and long-term financing needs.

The government plans to shift between 20 and 40 percent of its debt financing to Islamic sources from conventional ones, Dar said without specifying a timeframe.

Islamic finance is being used in deals involving foreign lenders, including large Chinese banks keen to revive ancient “Silk Road” trade links with Pakistan through CPEC projects.

The first CPEC transaction, a $1.95 billion loan syndication signed off in January to finance a coal mining project and associated power plant in Sindh province, was financed mostly by large Chinese banks. But the deal featured two sharia-compliant tranches worth a combined 16 billion rupees extended by Faysal Bank, Meezan Bank and Habib Bank.

“Given the diversity of the Silk Road I think we will see more structures like this,” said Andrew Compton, Hong Kong-based counsel at law firm Linklaters, which advised on the deal.

The transaction used a lease-based structure known as ijara, a common sharia-compliant contract. “This model is now out there, so this process could be replicated with some success.”

The law firm said it was working on other infrastructure transactions across Asia, including a hydropower plant and a wind farm in Pakistan and a coal power plant in Indonesia. (Editing by Andrew Torchia and Raissa Kasolowsky)